Employee or Independent Contractor? Why the 1099 Matters

As the first American set to orbit Earth sat in a tiny capsule atop a giant rocket in February 1962, fellow astronaut Scott Carpenter wished him good luck with a succinct, “Godspeed, John Glenn.” Moments before, however, Carpenter was cutting the tension with a line that immediately became part of the Apollo Program’s lore and lexicon: “Remember, John, this was built by the low bidder.”

While very few endeavors will have the gravity of cobbling together millions of parts to build a missile capable of putting a human into space, there are plenty of reasons to wonder if we are getting what we paid for when we go as cheap as possible. There is, of course, the suspicion that lower prices may lead to cutting corners that will be reflected in the quality of materials and even the level of care in craftsmanship. But what if that low bid came at the expense of labor laws and undermined the economic health of a community?

This is what happened with a Nashville-based heating and air condition company, which paid its employees as independent contractors, allowing the firm to avoid paying payroll taxes and unemployment insurance and giving them a way to severely undercut competitors when bidding on projects. As part of a recent extensive and fascinating series by McClatchy DC on the widespread practice of misclassifying workers, Tennessee’s Southern Mechanical was given particular attention for the company’s standard procedure of classifying its workers as independent “1099” contractors, although doing so may be in violation of state and federal laws. While Southern Mechanical would hardly be unique in this practice, the added fact that the company won numerous US government-funded contracts even while federal officials have spent years combating the 1099 scheme makes it seem particularly egregious.

So what do people mean when they refer to “1099 workers?” It’s a term for the kind of tax form an independent contractor receives instead of the standard W-2 an employee would get. Technically, the IRS has several 1099 designations, but the relevant one is the 1099-MISC, which according to the IRS is:

Generally used to report payments made in the course of a trade or business to a person who is not an employee or to an unincorporated business;

Required when payments of $10 or more in gross royalties or $600 or more in rents or compensation are made; and

Provided by the payer to the IRS and the person or business that received the payment.

The appeal for an employer using 1099 workers is that, like Southern Mechanical, they get the benefit of lower overhead and expenses, with a fair amount of flexibility to use independent contractors as they’re needed. The appeal for workers to be classified as 1099 is that they retain a good deal of autonomy, can usually get paid more than an employee (although they’ve got more responsibility when it comes to taxes), and have the ability to control how much or how little they work. Beyond industries like construction, there are freelancers in almost every profession imaginable.

What distinguishes an independent contractor from an employee largely boils down to the word “independent.” Consider two workers with similar jobs to do, such as landscaping a new yard. If the employer tells the first worker what is needed and then largely leaves it to the worker to figure out the best ways to get it done with minimal oversight and leaving materials and logistics to the worker, that person is probably doing the job of an independent contractor. If the employer tells the second worker what is needed, as well as how to do it and when to do everything, supplies them with tools, tells them which processes to use, and otherwise ‘manages’ them, the worker is much more likely to be classified as an employee.

In a slightly different context, consider that the landscaping job was estimated to take one worker 16 hours. If the first worker is an independent contractor who won the job based on a price with that time factored in, it behooves him to complete everything on schedule and becomes even more beneficial to finish ahead of time, since it pushes up the hourly average and frees him to do additional work or take personal time. Going longer than anticipated wouldn’t bring any additional income. Compare that to the employee doing the same job. For him, there’s no overt incentive to get the job done faster if he is paid hourly, unless there are merit or completion bonuses attached to the employment. In fact, quite the opposite of the 1099 independent contractor, the (short-term) benefit for the employee is to take longer than expected to reap additional wages.

Such was the thinking of Southern Mechanical’s president, who said of making his workers 1099 independent contractors: “It puts the monkey on their back to produce instead of being an hourly employee that hangs out on the job.” The problem is that it’s not really at the employer’s discretion to decide how workers are classified. That’s up to the IRS, whose criteria will, in simple terms, come down to “if it walks like a duck, talks like a duck, and swims like a duck, it’s probably a duck.” As far as the taxman is concerned, an inability to properly motivate hourly workers isn’t reason enough to reclassify them. In the case of workers like Southern Mechanical’s construction crews, to properly consider them independent contractors, the workers would need the freedom to set their own schedules, to own and use their own tools and supplies, to have credit with suppliers to buy necessary materials, autonomy to do the job as they saw fit without micromanaging, and appropriate compensation to cover all the expenses of a self-employed person, instead of the $20 or less per hour they’re likely getting.

On a more macro level, misclassifying workers has a huge ripple effect on the economy. In the McClatchy analysis of the construction industry, billions of dollars in annual tax revenue were lost every year due to improperly treating employees as independent contractors, mostly because those workers live in a shadow economy and don’t report their taxes as they’re supposed to, whether through intent or simple omission by ignorance of the requirement. When considering that as much as 20% of small businesses in the US are making similar mistakes, it becomes even clearer why the feds and states are getting more serious about cracking down on this. And those serious crackdowns come with serious fines. Multimillion-dollar penalties are becoming the norm instead of outliers.

If you’re in Georgia or Tennessee and have questions about classifying employees and independent contractors, contact an experienced Atlanta employment law attorney today at 1-877-986-5529. Mays & Kerr represents plaintiffs in employment matters, including employment discrimination, wage and hour, FMLA, and more. With offices in Atlanta and Nashville, we offer a client-centered philosophy and strive to accomplish our clients’ goals as if they are our own.